Fears of debt default by floundering European economies pose a "key risk" to the banking system, the Bank of England has warned.
Investors retreating from risk in the wake of the crisis which engulfed Greece in April could make it more difficult and expensive for banks to renew billions of pounds in existing funding, the Bank's latest Financial Stability Report (FSR) said.
The turmoil risked spreading to other weaker economies such as Portugal and Spain - prompting a slew of ratings downgrades and a joint 750 billion euro (£616 billion) bailout by the European Union and the International Monetary Fund in May.
This helped stave off an immediate catastrophe but "market pressures have not yet abated", the report warned.
Chancellor George Osborne's Budget this week launched a savage deficit-cutting package to underline the UK's commitment to repairing its sickly public finances and shore up the country's gold-plated triple-A credit rating.
But growth in Europe could be hit if investors shift their money towards healthier emerging market countries - putting further pressure on bank balance sheets, the report added.
The banking sector also faces risks from falling US and UK house prices as well as over-extended borrowers in commercial property - which could lead to growing corporate insolvencies, the Bank said.
The FSR warns a lending squeeze could choke off recovery, although banks also face a new Government levy on bank balance sheets which will eventually raise more than £2 billion a year.
The sector is meanwhile braced for a regulatory clampdown following the near-meltdown of the financial system, which will involve building larger capital buffers to meet tougher demands from regulators when the new Basel regime is agreed in the autumn.
"An extended transition to this new regime would enable banks to build resilience through greater retention of earnings, while sustaining lending," the report said.
